Michael  01:02

Our podcast sponsor today is StrategyTraining.com. If you want to strengthen your strategy skills, you can get the Overall Approach Used in Well Managed Strategy Studies. It’s a free download, and you can go to firmsconsulting.com/overallapproach. That’s firmsconsulting.com/overallapproach. And if you are looking to advance your career and need to update your resume, you can get a McKinsey and BCG-winning resume template as a free download at http://www.firmsconsulting.com/resumePDF. That’s http://www.firmsconsulting.com/resumePDF. Hey, Steve, how are you doing today?

Steve Hanke  01:53

Fine, fine. Thank you. How about you?

Michael  01:58

I am doing very, very well indeed. So excited to hear your thoughts. Let’s start with the big idea. Okay, rethinking the global financial rules, right?

Steve Hanke  02:05

The big idea is the fact that, particularly since the great financial crisis in 2008 and in particular once the COVID pandemic hit in February of 2020 the big central banks have had us on kind of a roller coaster ride. They first of all going to the pandemic, the most recent episode, every central bank hit the accelerator hard, and we had as a result of that, the money supply started growing very rapidly. And as always happens, when the money supply grows very rapidly with a with a with a lag, we got a lot of inflation, and then the central banks panicked and threw everything in reverse and literally started contracting the money supply. And of course, the inflation started falling like a stone, and then it’s still falling now. Why? Because they have excluded the quantity theory of money and all our modeling and thinking. They the central bankers in the major countries, let’s say the US, the UK, yes, and Europe, Asia is slightly different. They’re not quite as bad, actually, but the big ones in the West don’t adhere to the quantity theory of money, and in fact, they don’t think that there’s much of a relationship between changes in the money supply and changes in economic activity and inflation, which is just utter rubbish, yeah, complete rubbish. Now you wonder, why is this the case? And it’s the case because for the last 30 years, the economic models have been post Keynesian models, macroeconomic models that don’t include an aggregate measure for the aggregate money supply money is not included in the models, believe it or not, so, so the modeling is not there and and the research staffs as a result of that don’t deal With the quantity theory of money, and it’s just absurd. I’ve looked in history, there’s never been a significant inflation, and when I say significant, I’m talking about one of 4% or more per year that lasts for more than two years. That hasn’t been preceded by a significant. Significant increase in the monthly supply.

Michael  05:02

I’m going to ask what may seem like a very obvious question, how can all of the central banks make this mistake? Well, they copy each other. That’s what I was thinking. But I didn’t want to say it.

Steve Hanke  05:15

They copy each other. And in the dominant thinking really comes from the United States. In a sense, the United States is not only an empirical imperial power, but it casts a long shadow and in the behavior of other institutions, like other central banks, the Bank of England follows the Fed. The Bank of Canada follows the Fed. The ECB, the European Central Bank, follows the Fed. When, when I say the Fed, I mean the Federal Reserve in the United States, so, so the lead, the first mover, is usually the Fed and the United States and the other ones fall on they tend to do the same thing, but if everybody has the same armament, the same model and shooting the same kind of bullets, this is not very surprising.

Michael  06:18

Yes, but wouldn’t they have seen the result of following these models. Or do they think what’s happening in the broader world economics inflation? It’s detached from their policies?

Steve Hanke  06:30

Well, they’ve been able to rationalize the fact that they never could predict this increase in inflation.

Michael  06:40

By the way, I remember it was called temporary, yep, I remember that just a few years ago.

Steve Hanke  06:44

Yeah, it was temporary, and, and, and it was caused by exogenous shocks. You know, we had, we had the supply chain shocks with the shutdown of economies during COVID. Remember, remember that? Yeah, yeah. So this, this, by the way, is typical, and historically typical of all central bankers. Whenever something bad happens, like an inflation, yeah, they, they don’t want to blame it on themselves and themselves. They’re the ones responsible for monetary policy and changes in the money supply, which which cause changes in inflation. But they want to get the monkey off their back, so they always come up with what I call ad hoc explanations for why inflation occurred. It’s occurred because of oil prices going up, or supply change, change sharks or war or something that has nothing to do with the central bank, you see?

Michael  07:49

So basically, what they’re saying is, look, our models are right, except for the fact we didn’t take into consideration any real world events.

Steve Hanke  07:56

Yes, some something outside of our control has caused things to go haywire.

Michael  08:02

And if the world only behaves like our model, it would be so much easier. But that’s the way they’re approaching it, right, as if the world is wrong.

Steve Hanke  08:12

Well, it’s a little bit like look at the trade spat and all that, all these reciprocal tariffs and everything that President Trump’s trying to impose. No what? What’s he? He doesn’t like the fact that the United States has a trade deficit. He thinks that’s bad. Yeah, which? Which is wrong. Actually, it’s good, but he thinks, he thinks it’s bad. But the thing is, who causes it? He says that the foreigners are causing it? Yes, they’re ripping off the United States. Well, it’s the same kind of thinking as a central bank. The central bank is basically saying, you know, somebody else did.

Michael  08:52

Yes, it’s not taking a consideration the real world effects. So how do you fix this? How do you change this?

Steve Hanke  09:01

It’s, by the way, it’s a principle of, it’s not me, it’s a guy behind the tree.

Michael  09:07

You know, you know, they have these jokes about economists, if the model is wrong, you think the world is wrong, right?

Steve Hanke  09:13

So, so there’s a, there’s a lot of that in, in the in the picture, but they’re getting the policy is wrong, because in the United States, for example, the money supply should be growing at about 6% per year. That’s hanky’s Golden growth rate using the quantity theory of money, and can make a calculation putting the numbers in about 6% per year, and that would be consistent with hitting the inflation target of the Federal Reserves of 2% per year. So but the problem is it’s only growing up now 4.1% and by the way, since the summer. Or actually the spring of 2020 the money supply is exactly where it was way back in April of 2022 so it’s this flat line. So this has been the reaction, by the way, to the inflation. Remember the inflation peaked out in 2022 then they put everything in reverse, and the money supply actually contracted for quite some time, and then gradually started increasing, but at a very slow pace, it’s only growing now 4.1% that’s obviously well, well below 6% and, and, and that’s why inflation keeps coming down in the United States, with everybody said, Oh, inflation is going to kind of go up. No, it’s, it’s, it’s come down exactly as I predicted it would. It’s, it’s now running at 2.3% and I think sometime this year we’ll probably hit the inflation target at two, maybe even go below two. Now look at China. Yes, let’s go to China, the second biggest economy in the world. The hankies golden growth rate for the hitting the inflation target of 2% which is China’s new inflation target, is a little over 10% but the money supply has been growing at a very slow rate. In China, it’s only growing at about 7% per year, and and bingo magic. They have no inflation. They have deflation.

Michael  11:31

Yes, but it’s not something to be happy about.

Steve Hanke  11:35

No, it’s not something to be happy about. But the point is, it’s, it’s all connected the inflation, and in the growth and nominal GDP, which includes both, not remember, nominal GDP or nominal gross national product, includes real, the real growth rate plus the inflation rate. Yes, and, and so that’s you say, Well, what do we what do we want? We, when we look at the world, we we want robust growth and real economic activity, and we want stable prices with stable being, in this case, not, not zero, because they have this, this cock eyed notion that we have to have an inflation target. And the inflation target has to be you see how they copy you percent. The Fed’s inflation target, China’s was 3% but they changed it at the end of the year to 2%.

Michael  12:36

So this entire response of withholding money supply is to contain inflation. Now that inflation seems to be leveling out, what should the Fed be doing?

Steve Hanke  12:47

Well, the Fed should, number one, they should remove what they’ve been calling quantitative tightening. Yes, they’ve been, they’ve been shrinking the contribution that the Federal Reserve makes to the money supply and and that’s why the growth rate is 4.1% it should be 6% so should they should get rid of quantitative tightening. The money supply is growing at an anemic rate right now. And, and as a result of the fact that the money supply is literally not, not gone any place since April 2022 we will have a slowdown and probably a recession in the United States this year.

Michael  13:28

So coming back to the numbers you presented 2.8 you said it could go down to 2% that’s taken into consideration what’s happening with tariffs and so on.

Steve Hanke  13:38

Yes, because the tariffs that that that everybody says incorrectly, oh, the tariffs are going to cause inflation. Inflation is always in every word, caused by changes in the money supply. So what are the, what are the what happens with the tariffs? They change relative prices, the things that are imported into the United States that had big tariffs on new tariffs, those things that would go up in price, but up relative to every everything else. And if the money supply is not changing, some of the everything else will actually go up more slowly. This balance is out. It balances out the thing that moves the aggregate, that we have over 300 items in the consumer price index in the United States, and those things move all around those 300 that’s the relative price change thing going on. But what moves the level of all of them in aggregate is the money supply. And if the money supply is anemic and shrinking, the price level won’t rise at a rapid rate. It could be a slower rate.

Michael  14:51

And when you were predicting a recession, what’s your reasoning for that? Why do you feel there’ll be a recession?

Steve Hanke  14:57

Because the money supply is. Well, it actually contracted until very recently. So we’ve had this. It should have been increase. We should have had a 6% increase in the money supply on an annual basis. And we’ve had zero since April, 2022 so given that we know that what happens? You change the money supply. You look at what changes are in the money supply, and with a lag, with a long lag, a long and variable lag, the real economy, economic activity will change, and inflation will change.

Michael  15:38

So what’s interesting about this, and I really like the conversation is that it’s grounded in economics. But when you read the Wall Street Journal Financial Times and The New York Times, a lot of reporters get caught up in the hype of what is happening without looking at the fundamentals.

Steve Hanke  15:56

Well, this is correct, because they echo what the central banks are doing. Not the central banks are not only echoing what each other are doing. As I pointed out before the journal, the journalists just echo whatever the central banks are saying, and what are the central banks saying, what the central banks do, they don’t really even adhere to these post Keynesian models that exclude the money supply. They’re the central banks. Are data dependent. They’re looking at what the data, financial data and economic data are saying, day by day, by day by day, and they don’t realize that they have no model. They’re flying blind. They’re just looking at the data. They have their finger in the wind, so to speak, looking at the data, and they don’t realize that what caught, what caused the changes in the data that they’re looking at today is something that happened with changes in the money supply two years ago or a year ago or three years ago.

Michael  17:02

So what you’re saying, it’s a little bit like astronomy. What we see today is not what’s up in the skies. It’s a millions of years ago now, in this case, is that millions of years ago, the data they’re analyzing is old data, and it’s not reflecting what’s happening in the world today.

Steve Hanke  17:16

Absolutely, that’s exactly that’s a very good analogy you just put forward.

Michael  17:21

Thank you. So the issue is the money supply is tightening that will cause inflation, and unless the money supply changes, we’re heading towards the recession, not inflation, right?

Steve Hanke  17:32

And so then, then you ask what your original question was? Well, what, what’s the state? What’s the state of the financial world or economic world, if you want to put it that way, that was your initial question. And then, and then the obvious follow up is, you know, I I’ve given you what the Void is, what the error is. So how do you change that? And I think, I think this new book that Matt surki and I co authored that is released by Wiley on May 6. It’s called Making money work. And that book advocates getting money back at the center of things that is the model, the quantity theory of money, and we go into quite some detail, kind of a new, new generation of thinking about the quantity theory of money. It’s new, because, by the way, the quantity theory of money has been around since the 16th century. Yes, it’s been around for hundreds of years. We just have a new and more robust version of the whole thing in making money work. And there are two things in making money work. Number one, getting the quantity theory of money and money back in the macroeconomic picture where it should be, yes, and getting banks back at the commercial banks back at the center of this monetary and financial regime, because most people don’t realize they look at central banks and they that’s all they look at what what’s the central bank doing? But the elephant in the room is actually commercial the commercial banks, because about 80% of the of the stock of broad money held by the non bank public is is actually produced by what commercial banks, not the central banks. So the policies that surround commercial banks are, are part of monetary policy, and they’re and it’s very important that we look at these and understand them and and allow commercial banks to get back back in the in the center of the game since, since the great financial crisis in 2008 they’ve, they’ve been kind of squeezed out of the game. Yeah, they’re, they’re not, they’re not as important, and they’re not functioning as well as they should. So given the bank regulations that were imposed after the great financial crisis, mainly the Dodd Frank legislation coming out of Washington, DC, but there also was, there were also new regulations coming out of Basel, so called Basel three, all of this put a cramp on the banks, put a noose, basically around their neck.

Michael  20:26

You know, what you say makes a lot of sense to me. In my previous life, I used to be a management consulting partner, and I remember when we’d work with clients in banking in particular, all of those clients would be admiring and looking towards a particular US Bank, and whatever that US Bank did, they would copy it because they felt the Americans had best practice. And you go from client to client and they end up copying the bank without understanding the context for why that US Bank was doing what it was doing, and that context didn’t apply to the country we were serving at that point. So I can very clearly understand why central banks copy the United States. It makes sense in any industry, there’s always someone that has been copied, who is setting the benchmark, who is revered, who has eminence. But at a certain point, the people who are advising the central bank must know these things that you’re talking about. Why are they not implementing it well?

Steve Hanke  21:25

You have, you have, you know, all the international organizations, the g7 the g20 all these groups that it’s a club, yeah, and all these, all, all the members of the club coming from far away, places China and India and so forth. What do they want to do? Well, they want to copy the leader. They want to they want to shadow the leader, do what the leader is doing. And so that’s why it happens that way. But, but, but you have to remember that this, is very interesting. The point you’re raising because inflation, remember, in COVID, the one reason that they got into this, you know, not me, it’s a guy behind the tree kind of thing, and blaming somebody else, everybody said, Oh, it’s international. It’s inflation’s global. Yes. Well, it was, in a sense, because a lot of countries were copying each other, and then, in that sense, it was global. But in fact, inflation is always local. It’s always due to changes in the money supply and whatever locale you happen to be in. Now, if all the locales are copying each other doing exactly, of course, it looks, it gives the appearance of being global, but it’s not. It’s created locally. And another thing that throws a journalist off, and the central banks lead them in this way, is that everybody watches what they watch, the federal funds rate and the local interest rates that those rates that are controlled by the local central banks? Yeah, that’s all they watch. But, but monetary policy is not about interest rates. It’s about changes in the money supply. So they’re just not looking at the right thing. The whole thing is just very bizarre, actually, in the sense that it’s just wrong headed.

Michael  23:22

I agree with what you’re saying. It makes a lot of sense. Because, for example, when I look at companies, when they report their performance, when I advise companies, the thing I care about the most is, are they earning their cost of capital, or are they not earning their cost of capital? Because you’re then destroying value. But when you see the way the business press talks about company performance like the way they talk about economic performance. People have their own indicators that they want to look at without looking at the most important indicator, which in this case is money supply.

Steve Hanke  23:54

Exactly, exactly. I mean if, if you’re look at it this way, another analogy, and this is what the central banks do. If you’re looking in the rearview mirror, you got a big problem, because you might have a mountain up ahead of you you’re gonna hit.

Michael  24:10

Oh, I like that analogy. What can they do? They can only look at data from the past, but what you’re saying is they need to adjust for what’s happening in the real world?

Steve Hanke  24:22

Well, they must have their hands on the on the right policy levers to adjust the money supply growth rate to something in the US, as I said, at about 6% that would, that would hit, allow them to hit the inflation target at 2% and that by the way, that was happening in the 1990s yes, if you look at what was happening in the 1990s the money supply, measured by him to a broad measure, the money supply, it was growing more or less around Five 6% and inflation was running pretty close to 2% just a tad below. Actually 2% but it all that’s the way it worked. So they have to adjust things so that the money supply grows at a correct and stable rate. And instead of hitting us on this roller coaster what happened in COVID in the United States, they goosed the money supply, and it was actually growing at the peak a little over 18% year over year. That was the highest rate of growth that’s ever occurred in the money supply m2 in the United States, ever since the Fed was founded in 1913 and then it went negative.

Michael  25:44

So first it’s the roller coaster, up down, yeah, it’s over correcting, as they say.

Steve Hanke  25:47

It should just be flat lined at around 6%.

Michael  25:51

You know, it reminded me of clients after COVID, and there was this huge push for consumers to buy things. I had clients who looked at the post COVID consumption patterns, and they started investing wildly in increasing productions. But I always warn them that you’re looking back at data that’s a year old and the future is not going to have that kind of demand. It’s the same problem, right? Looking at past data and making decisions on the future based on data that is not reflective of what’s coming ahead.

Steve Hanke  26:22

Yeah, you’re exactly right. And think this, this use some common sense. The common sense would be, what that COVID, COVID was pretty much an anomaly in the sense that, how many times in history have major countries actually made it illegal to go to work?

Michael  26:40

I can’t think of any time, actually.

Steve Hanke  26:43

Yeah. I mean, it’s, it’s incredible. So what, why would you base your thinking off of that anomalous episode now, now, by the way, when you’re running a business, and as you know better than I do, given your expertise, the best way forward is to the baseline, is to think in terms of we’ll do next year what we did this year, or if last year was a bad year, you’ll make adjustments to whatever You’re doing to accommodate those errors that you made the year before. But it is the past year and the pattern of past years that that guide businesses. They don’t just put their finger in the wind and or get get some crystal ball out of the closet and start making if you do that, by the way, you can get yourself in a lot of trouble. And even thinking about inflation, the best forecast for inflation, by the way, the most accurate one, is to look what was inflation last year? And why is that? Because of what this money supply thing, yes, yes, talking about comes into the picture that’s behind it. That’s That’s why last year’s inflation is a pretty good guide to what’s going to happen next year. Because prior to last year and and next year are those changes in the money supply that have preceded those two years that will actually determine what’s going to happen with inflation, and that’s why inflation, in that sense, is kind of baked in the cake. So what I’m talking about inflation this year in the United States going down to from its 2.3% rate, current rate, headline, CPI, to something close to 2% or maybe below. That’s all baked in the cake. It has nothing to do with Trump being president, or anybody could be president, and that would happen because of the changes in the money supply that have occurred in the last two or three years?

Michael  29:02

Yeah, so for the audience, basically what you’re saying is inflation is a lag indicator for the behavior of money supply.

Steve Hanke  29:11

Yeah, that’s one way to look at it. It is a lag indicator. What’s happening with inflation today is precisely what happened a long time ago with the money supply. Now the trick and the art in this, yes, we’re talking now about the science of it, but there is an art because the lags are long and variable. Yes, yes. So you it isn’t like just plugging something into a simple arithmetic formula and saying, you know, in 12 months, yes, well, change by this much, because 12 months before the money supply changed by this month. Because, in fact, the typical lag for inflation and changes in the money supply in the US is about is 12 to 24 Months. So you have a whole year of variability in there.

Michael  30:04

Yes, it’s like standing at the beach, right? You know a wave is coming. You just don’t know whether the next one’s going to be the big one. So you know that, based on changes in the money supply x, is going to happen to inflation, but you don’t exactly know when it will happen, right?

Steve Hanke  30:18

Yes, and that’s the art. And the thing you have to be able to, you know, read the tea leaves pretty well, the hone in and get it, you know, close in terms of a quarter, for example. So these relationships are, are solid in fundamentally, but they’re kind of the actual readings that you get and measurements and so forth of the effects of changes in the money supply. That’s that’s a little trickier game. Yeah, it’s not, it’s not a simple little formula you put in.

Michael  30:58

A good analogy that comes to mind for me is the way clients, CEOs have to time when they’ll make large capital investments, and they have to figure out what the impact is going to be on the organization, how it’s going to impact behavior, spending patterns, increases in salaries and so on. So you know, if you release a lot of money into a company X is going to happen, but timing it is difficult. It’s the same principle, isn’t it?

Steve Hanke  31:27

It’s exactly the same principle. And I like thinking about a business, because right now, let’s, let’s, let’s keep up with your example here, because it’s a good one. Right now we have this money supply factor baked in the cake that will slow down the US economy doesn’t matter if Trump’s there or whoever is there. Now, in addition to that, though, we do have Trump, and Trump’s administration is changing so many things and threatening to change, and changing their mind and so forth, that you have what I call regime uncertainty. The whole regime is up in the air. And if you look at business investment, it’s come to a halt. And why has it come to a halt? Because the guy investing, the firm investing, is investing money that the returns from which will occur sometime in the distant future. And N they’re uncertain about just what the rules of the game will be that are going to be surrounding that new plant that they’re thinking about investing in. Yes. So what they do? They just stop. They say, Okay, we’re gonna we’re gonna hold off until we figure out what the rules are going to be. Now, the only time we ever had this kind of phenomenon, regime uncertainty before was in the Roosevelt administration, Franklin Delano, Roosevelt and the New Dealers, the New Deal. This during the Great 1930s a Great Depression. And what happened is that the New Dealers came in. They were like Trump, changing every everything was changing. And investment stopped. It just stopped and and it stopped in 1929 actually, and and 1930 and, and it never started up again until the second right before the Second World War. Now, the effect of that was that it made the Great Depression deeper than it would have otherwise been. You drug it out for much longer than it would have been if you hadn’t had this regime uncertainty. That’s why I’m pretty certain this year we’re going to have a recession in the United States. Point one is what I with, anemic money supply growth. Point two is a regime uncertainty that does exactly what you said. It just hampers investment. People just hunker down. They say we’re going to wait. We’re going to wait till this storm clarifies, and before we do anything.

Michael  34:17

I like that example of thinking about it, because it’s a good analogy to think about what the levers are, what the pressure points are, how people are likely to react. But it’s interesting for me that we had to go all the way back to the Roosevelt administration to find a regime that created so much uncertainty.

Steve Hanke  34:34

Yes, you always have, as you know, as a management consultant, there, there are little pockets of uncertainty, always, always, little here, there, everywhere, but, but once, once you have everything changing at once, all the big stuff, then you have what I call regime uncertainty. That means the whole regime is changing. Not, not just one little pin prick here and there that a. Affects one little industry here and there, but everything, or many things, start changing in a big way. And when that starts happening, you have regime uncertainty. And the only example in the United States that I have for that is the new deal now we had a lot of regime uncertainty. Think about, think about the Soviet Union and all the republics in the Soviet Union after, you know, everything collapsed in there. In 1989 1990 1991 there was a massive amount of regime uncertainty. No one knew what in the world was going to happen.

Michael  35:41

Yes, that’s actually a good analogy, because basically everything froze. No one knew what was happening.

Steve Hanke  35:48

Yeah, no one knew what was happening. And the countries, by the way, that that did the best, the post Soviet economies that did the best, were those that put new rules of the game in place faster than others did. In other words, the those, in general terms, those that reform more rapidly.

Michael  36:12

Yeah, that makes sense. I’m reading Mark Mobius, his book on his investments in emerging markets, and he mentioned the same thing, the ones that performed the worst, they waited too long to see what would happen, and the ones that performed the best gave guidance to investors, as you call it rules, right?

Steve Hanke  36:33

So now, speaking of Mark Mobius, who happens to be a good friend of mine, and I mentioned this book that Matt sekirk and I wrote making money work. Mobius was one of the individuals who endorsed that book. He’s he Mobius is on, if you look at the dust jacket that book, yes, Mobius isn’t his dust jacket endorsement is, is, in fact, on the dust jacket.

Michael  37:02

Oh, wonderful. So I know you have something coming up in a few minutes. Is there any place our listeners can go to to get more information about you? Your work? I know there’s a book. Anything else?

Steve Hanke  37:15

Well, yes, I think they can follow me on X. I’ve got over 800,000 followers, a third most of any economist in the world, and my handle is @steve_hanke. That’s that’s one place where they get in a real time information. The other thing is, I put out a distribution of all my interviews, articles, things like that, every week, for example, this discussion that we’re having, I’ll have this included in my weekly distribution. And if people want that little package, they just write me an email, [email protected], that’s my email. And just say you want to be on my you’d like to be included on my weekly distribution, and I’ll put you on.

Michael  38:06

Fantastic. I actually enjoyed this interview immensely. I think our listeners will like it as well. I found that you have a very nice way of making economics accessible, which is a very rare skill.

Steve Hanke  38:19

Well, I appreciate that compliment. I’ve enjoyed your questions as much as I’ve enjoyed responding to them.

Michael  38:26

Thank you so much, Steve. I know you’ve got a call. We’ll be in touch, and I look forward to speaking to you again soon. Thank you and take care. Ciao. Ciao. As we wrap up, today’s podcast is sponsored by StrategyTraining.com. If you want to strengthen your strategy skills, you can get the Overall Approach Using Well-Managed Strategy Studies as a free download. Go to firmsconsulting.com/overallapproach. And if you’re looking to advance your career and need to update your resume, you can get a McKinsey and BCG-winning resume template example as a free download at http://www.firmsconsulting.com/resumePDF.